Consolidation Squeezing Cardinal Health

Cardinal Health (CAH) is one of the three biggest players in its field, which is distributing drugs and medical supplies to pharmacies and hospitals. Three firms, Cardinal, McKesson (MCK), and AmerisourceBergen (ABC), dominate the space. But consolidation among pharmacies has shrunk the opportunities, squeezing Cardinal.

Independent mom-and-pop pharmacies are the best customers for Cardinal Health, as they need its services most. Meanwhile, the big chains have price leverage over Cardinal and can take care of their purchasing and distribution requirements themselves.

Yet Cardinal is more and more dependent on the big players, with CVS Pharmacy (CVS) and Walgreen (WAG), accounting for more than 45 percent of its sales in fiscal 2010, according to Morningstar.

The bulk of Cardinal’s business comes from providing drugs to the benefit managers and pharmacy chains. But those customers provide a profit margin of 0.3 percent, compared to 2 percent for servicing individual retail pharmacies, according to Morningstar.

Cardinal also is being squeezed by the growth of pharmacy benefit managers, principally Medco Health Solutions (MHS) and Express Scripts (ESRX). These managers encourage their customers to receive prescriptions via the mail, which leaves Cardinal out of the loop.

Cardinal’s operating income rose 7 percent in the quarter ended June 30 to $207.3 million from a year earlier. Revenue gained 9 percent to $26.8 billion.

Beautiful buyouts

Standard & Poor’s analyst Herman Saftlas has a four-star buy rating on Cardinal Health shares. He is impressed by three acquisitions the company made last year.

It bought Healthcare Solutions, a specialty (oncology) pharmaceutical services company, for $517 million.
Cardinal also purchased Kinray, a drug distributor serving more than 2,000 independent retail pharmacies in the New York City metropolitan area for $1.3 billion.
And finally it acquired Yong Yu, a leading pharmaceutical distributor in China, for $470 million.

“We expect these deals to contribute importantly to earnings-per-share growth over the coming years,” Saftlas writes. “We also view Cardinal’s cash flow as healthy, providing financial flexibility for business expansion, dividends and common share buybacks.”

Cardinal Health (CAH) is one of the three biggest players in its field, which is distributing drugs and medical supplies to pharmacies and hospitals. Three firms, Cardinal, McKesson (MCK), and AmerisourceBergen (ABC), dominate the space. But consolidation among pharmacies...